Dic Finance

DIC wants to acquire a seemingly profitable private rehabilitation centre that last year (Year 4) generated £1.3 million profit.

The acquisition cost will be £2 million and the company’s intention is to ran the plant for six years and, afterwards, sell it for £1 million.

Actions between Year 5 and Year 6

Year 5 and Year 6 – Before operations commence

• Acquistion

• Dismissal of Chief Executive due to cost saving measures

Year 6 – After operations commence

• Further steps to increase revenues on a regular basis and to stabilise costs.

• Appointment of existing employee as CEO.

• Takeover of operations

Assumptions: Year 6 onwards

Not so obvious cash flows

1) Fixed cost was £800,000 till year 5 but after acquisition due to exit of chief executive and other cost saving measures it will be reduced to £500,000. Therefore,

£800,000 - £500,000 = £300,000

Cost avoided is £300,000 by undertaking this project.

2) Depreciation of existing building is considered a sunk cost because the full purchase has already been incurred and cannot be changed or avoided in the future.

3) Equipment 1 is disposed at a value less than its net book value (NBV) after operations commence. Therefore, the NBV of the machine minus disposal value is the opportunity cost.

£500,000 - £100,000 = £400,000.

Obvious Cash Flows

1) Operating fixed cost including salaries of the employees and some other costs. DIC will incur on this cost because this is a new acquistion.

2) Several other costs like marketing, equipment and operating variable cost.

Recommendation

The statements show that the prison is capable of generating profit and of sustaining positive Incremental Cash Flows from Year 6. So as long as the initial outlay value remains unchanged and the operational and financial improvements are made, the acquisition will be profitable and will contribute to DIC’s growth.

DIC will have a postivit ICF of approx £11.7 million by year 11